Question

Ken is a self-employed architect in a small firm with four employees: himself, his office assistant, and two drafters, all of whom have worked for Ken full-time for the last four years. The office assistant earns $30,000 per year and each drafter earns $40,000. Ken’s net earnings from self-employment (after deducting all expenses and one-half of self-employment taxes) are $310,000. Ken is considering whether to establish a SEP plan and has a few questions:

Is he eligible to establish a SEP plan?

Is he required to cover his employees under the plan? Why or why not?

If his employees must be covered, what is the maximum amount that can be contributed on their behalf?

If the employees are not covered, what is the maximum amount Ken can contribute for himself?

If Ken is required to contribute for his employees and chooses to contribute the maximum amount, what is the maximum amount Ken can contribute for himself? (Hint: Calculate the employee amounts first.) Ignore any changes in Ken’s self-employment tax.

Use 2018 tax laws

Answer 1

Information Given -

Ken is a self-employed architect in a small firm with four employees: himself, his office assistant, and two drafters, all of whom have worked for Ken full-time for the last four years.

The office assistant earns $30000 per year and each drafter earns $40000.

Ken’s net earnings from self-employment (after deducting all expenses and one-half of self-employment taxes) are $310000.

.

(a) -- Is he eligible to establish a SEP plan?

Answer -

Yes, Ken is eligible to establish a SEP plan.

.

(b) -- Is he required to cover his employees under the plan? Why or why not?

Answer -

Ken must cover all his employees, since they have worked for him at least 3 of the last 5 years and they all earned at least $600 in compensation.

.

(c) -- If his employees must be covered, what is the maximum amount that can be contributed on their behalf ?

Answer -

The maximum amount that Ken can contribute on their behalf cannot exceed the lesser of 25% of their earnings or $55000 maximum, for the tax year 2018.

Hence, ken can contribute maximum [($30000+$40000+$40000) * 25%] = $27500 on their behalf, for the tax year 2018.

.

(d) -- If the employees are not covered, what is the maximum amount Ken can contribute for himself ?​​​​​​​

Answer -

If the employees are not covered, the maximum amount Ken can contribute for himself is Zero, because he would not be qualified to have a SEP plan.